Junk status means SA will have to pay more to raise money for economic growth and service delivery: analysts

Junk status means South Africa is going to have to pay more to raise the money it needs for economic growth‚ key projects and service delivery.

Interest rates will most likely rise‚ thus increasing the monthly cost on things like home loan and vehicle finance repayments.

That’s the view of Ian Matthews‚ head of business development at Bravura‚ who was commenting on the downgrade to “junk” status of South Africa’s sovereign rating on Friday by S&P Global Ratings.

Moody’s maintained the country’s rating above junk but placed it on review for a downgrade

“This outcome is more positive than if S&P Global and Moody’s both downgraded the local currency rating. If both Moody’s and S&P downgraded South Africa’s local currency debt to junk‚ South African bonds would fall out of the Citigroup’s World Government Bond Index (WGBI)‚ causing large international tracker funds to sell out of their holdings of such bonds‚” said Matthews.

Ejection from the crucial bond indexes meant passive investors mandated to invest in local bonds would automatically have to withdraw from those investments‚ he said.

“Downgrades to sub-investment grade could trigger forced selling of up to as $14bn of outflows‚ according to the Bank of America. If S&P and Moody’s‚ therefore‚ both downgrade South Africa‚ then far greater losses on the rand can be expected. The rand could depreciate rapidly‚ causing inflation to increase‚ putting upward pressure on interest rates and downward pressure on economic growth.”

However‚ Matthews warns that S&P’s decision will see South Africa excluded from the Barclays Global Aggregate index‚ whose inclusion criteria requires investment grade rating on its local currency debt from any two ratings agencies. South African debt has already been dropped from one of the widely used global bond indexes‚ the JPMorgan Emerging Market Bond Index Global.

Foreign investors are already turning cold on South African bonds‚ data from the Johannesburg Stock Exchange show‚ with daily outflows over the past month averaging R134m‚ he says.

“Junk status means South Africa is going to have to pay more‚ to raise the money it needs for economic growth‚ key projects and service delivery. Interest rates will most likely rise‚ thus increasing the monthly cost on things like home loan and vehicle finance repayments‚” Matthews adds.

Tumisho Grater‚ economic strategist at Novare Actuaries and Consultants‚ says that while outflows are anticipated‚ they are not likely to be as large as what might be expected should South Africa fall out of the Citi’s World Government Bond Index (WGBI).

“The slip in the credit ratings increases the calls for reforms even louder and falling deeper into the red (In the instance that Moody’s follows suite after the 2018 February budget)‚ may lead to more aggressive falls in the rand‚ government bonds and business and consumer confidence- which is needed to attract investment‚ create jobs and grow the economy‚” says Grater.

She notes that despite South Africa falling off the JP Morgan Emerging Markets Index earlier this year‚ the hunt for yield didn’t suppress global investors’ appetite for South African bonds.

“However‚ a faster than expected pace of monetary policy tightening by global central banks posed a threat to these capital flows too‚” she says.

Before the Global Financial Crisis (GFC)‚ she points out‚ non-residents held about 7% of domestic currency government debt. This ratio increased to current levels of around 40%.

“This is a positive development and is reflective of South Africa’s deep and liquid domestic bond market. However‚ the concern is that the increased holdings makes South Africa more vulnerable to changes in non-resident sentiment.

“Sub-investment grade credit rating (and in this instance on the local denominated sovereign debt)‚ prevents many institutional investors from holding South African bonds‚ resulting in capital outflows.

“With that said‚ the short-term impact will also depend on how much is already priced into the markets‚ the extent to which positions have already been reduced‚ and whether the buyers of these bonds are residents or non-residents‚” says Grater.